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Monthly Archives: August 2004

BACK TO BASICS

THE Enron fiasco, ending up in a US court, reminds us first that the “new economy” was just another scam. Reputable financial institutions conspired with ruthless, greedy entrepreneurs and unscrupulous management to peddle it. They had everything to gain and nothing to lose.

Second, the basic rules of business have not changed one iota since the days of the pharaohs. So, you may ask: “What are these basic rules of business?”

There are a few. However, the only business success imperative is probably the cash-to-cash cycle. Its compounding velocity seems to govern the very viability of a business — its productivity and competitiveness.

The cycle has nothing to do with the fashionable distinction between “tangible” and “intangible” assets. Nor does it drift into “mind-screwing” analogousasset theories that refer to people, intellectual property or brands as assets.

At any rate, when the collapse came, that is what shareholders of Enron, Cisco, Worldcom, Marconi et al, including our own Didata, must have felt. In 2002, even Richemont’s management had to slash about $3,5bn off the value of its “maisons” as it got busy speeding up the company’s neglected cash cycle.

Bruce Henderson, the late founder of Boston Consulting Group, made a typically trenchant observation on this issue: “A business is a cash-compounding machine or it is nothing — and sooner or later will be swept away.”

If it is such a machine (which it may or may not be) then we know what speeds up or slows down compounding. And you don’t need rocket science to compute it. Standard 4 or 5 arithmetic will do just fine.

Simplicity wins. To change an organisation fast, use one measure — not many of them. That’s what Adcorp — a one-time promoter of the “intellectual asset” myth during the scam years — has done to great effect.

A Harvard Business Review article (June 2002) — Lessons from Private Equity Masters — influenced Adcorp later the same year. Normally, there is little or no overlap between “knowing” and “doing” — especially common among senior executives who feel they have the power not to have to learn anything. However, this time not only did the Adcorp team learn, but it acted fast.

Successful private-equity firms routinely achieve eye-popping economic returns from the companies they control. How do they do it? Like a searchlight in the night sky, they focus relentlessly on a simple management agenda. They narrow their aim to expand returns.

They first demand an investment thesis that focuses on opportunity, not problems of the past: “How can you make your business more valuable in the next three to five years? What two or three fundamental changes must you make? What should you prune? Where must you invest to grow?”

Second, use simple measures — not complex ones like “balanced” scorecards, or CFROI, an accounting return measure. They lead to bureaucratic, measurement mania, rarely any meaningful productivity improvement. Watch cash more closely than earnings, and add bite to measures by tying the equity portion of managers’ pay to their own units, not the parent company.

Today, the reality is that corporate management answers to nobody. Under the indulgent gaze of lily-livered boards, executives set their own pay and allocate themselves share options to create a spurious sense of “ownership”. Sadly for shareholders, there is no correlation between these schemes and sustainable economic productivity. They become merely another means for managers to “take” money — not “make” money.

Third, work the balance sheet. Eliminate unproductive capital and treat equity as precious and scarce. Use debt — up to 60% — to gain economic leverage and focus the minds, but match risk with return.

Fourth, make the centre the shareholder. Keep it lean by having only five people for every R1bn managed. That rule of thumb reduces the typical corporate office by 75%. It also means that operating managers don’t have to allocate precious time and resources feeding data “carrots” to bureaucratic “donkeys” who always gobble up as much as you can give them.

The centre’s task is to provide support, advice and to hire and fire operating top management. Its guiding statement of intent is: “Every day we don’t sell a portfolio company, we have made an implicit ‘buy’ decision.”

Two years ago Richard Pike, Adcorp’s MD, put himself in the shoes of the shareholder. Unless a manager thinks like an owner, he cannot act intelligently or with integrity.

His view is: “A profitable company may not generate cash. However, cashgenerative companies tend to be profitable and are assured of survival.”

Today, after walking round his company explaining his simple agenda, not the vision-mission-values stuff, Pike manages a much simpler, more productive and far more valuable business.

Secure in the knowledge that there is always huge, untapped potential lying dormant among people in every company, Pike used the ROAM (return on assets managed) model to clarify operating management’s task.

For a year, his people focused on the cash-to-cash cycle — in particular, the cash owed by customers. But this is not to say that Pike ignores other measures — far from it.

For Adcorp, there are four key ones within the ROAM model. However, debtors’ days received most intense focus for the period under review.

Today, operating margin is under the microscope.

Adcorp also applied the 80:20 law of focus to weed out underperforming businesses and unprofitable market segments. There were 28 business units in 2002. Now there are 12.

These are the economic effects:

ROAM improved from 23% last year to 30,4% and

the value of the firm increased from R250m to R620m in two years.

Managing is not easy, and life is far tougher than it was even a few years ago. That means only tough-minded, highly disciplined managers who think like owners will win the day.

Pike and his team made a “breakthrough” last year. They discovered that a simple agenda that leads to concentration and focus on opportunities is the best way to manage.

The top private equity firms are good models to emulate. Adcorp has done that to great effect so far. All that remains is for its people to build on their success and continue converting their simple investment thesis into reality. Black, a writer and executive coach, is an associate of the Da Vinci Institute

Black, a writer and executive coach, is an associate of the Da Vinci Institute.